Yes, You Want The IRS To Target “Low Income” Filers

US Treasury Sec. Janet Yellen saying the IRS won’t target filers earning less than $400k is kind of like a police commissioner promising not to target the poor. Sounds progressive, but it feels too good to be true, perhaps conflicting. Can you really deter or investigate crime without focusing on low income communities? Well if it’s violent crime you should actually be focusing on the issues that compromise people and families or deprive them of resources, and similar can probably be said about non-violent property crimes. Otherwise – beyond focusing on the root of the problem – you’re pretty much doomed to police the poor if you’re going to fight crime, as poverty is correlated with crime.

The IRS too can’t actually address the tax gap without inevitably scrutinizing filers making well under $400,000, but not for the same reason or any of the ones you’re probably imagining.

Not Just Corporations: The Wealthy Are Great At Looking Income-Poor

My years as a personal income tax economist were a crash course in how frustratingly simple it is for otherwise wealthy residents to be income-poor, and therefore tax-poor. You’re probably more familiar with a similar corporate problem of accounting standards and tax breaks that allow companies to look tax-poor while returning profits to shareholders. In this case it’s not really an accounting gimmick; some filers actually earn little to no annual income while living in ways inaccessible to 90% of New Yorkers.

In some cases otherwise high earning filers can carryforward unused portions of losses and deductions from prior tax years, report exaggerated losses on fringe forms of business, or use losses from stocks to effectively cancel out their current year gross income, resulting in no taxable income. But addressing that kind of “low-income” fraud for the most part is as simple as IRS auditing targets denominated in terms of gross, unadjusted income rather than taxable (post-deductions) income.

Yet many arguably wealthy filers are strategically claiming little to no income on their tax filings intentionally to qualify for means-tested tax credits like the EITC and the Child Tax Credit.

True Welfare Queens: How The Asset Rich Appear Income-Poor And Get Free Government Cheese

Indeed, appearing income poor enables you to not only avoid taxes, but also to unethically benefit from the income redistribution done through our tax regime. We often forget that our tax framework doesn’t only take money from filers, but for the bottom 40% of personal income tax filers nationwide the system actually returns back withheld taxes and transfers additional funds from the government to filers. It’s an underappreciated but critical part of combatting the income inequality inherent in capitalist economies and fostering social justice, one that’s undermined when tapped by wealth hoarders instead of poor and working-class filers.

Most of the lowest 40% of earners in the United States owe no personal income tax or receive refunds

Those wealth hoarders may not be earning a wage, collecting interest, or selling stocks, but they’re abstaining from these taxed events selectively. Unlike truly low income filers who may be unemployed, underemployed, or otherwise undesirable to collect from under first principles of progressive taxation, these people are setting up other forms of cash flow that don’t trigger a tax event. They’re not only living far more secure lives than the average low-wage filer, they’re collecting public benefits meant to offer some modest relief from entrenched income inequality!

Just because these benefits flow through the tax system instead of from the budget doesn’t make these capital accumulators any different from “welfare queens.”

The mechanism for this is always some version of borrowing against capital. These filers are using borrowed funds to meet current expenses, and because of their accumulated assets and savings – wealth – and their credit worthiness it’s easy for them to attain single digit interest rates that are far lower than what would be their effective income tax rate. When tax time comes they register little to no wage income, and perhaps no income of any sort otherwise but certainly “farming losses” (I never saw a NYC filer profile that claimed farming gains) and capital gains losses from building sales that, when sprinkled with a few charitably donated stocks magically leads to the likes of the Trump family receiving tax refunds larger than any received by a minimum wage worker.

Personally, these weren’t one-offs. A significant contribution to our annual forecasting errors probably came from these wealthy filers who may one year present as millionaires and the next year as paupers. And the State did little to help us connect the dots on how these filers behaved over multiple years in the City.

And the IRS is aware of abuses and mistakes in EITC claims, but somehow that’s translated into aggressively auditing low income filers in clearly low income counties. These filers are obviously less likely to have a silent Fred Trump hiding among them making no money while borrowing against their skyscraper and second home, yet they’re exponentially more likely to be audited than the wealthiest filers.

Is The IRS Really The Hero Here?

None of this means that “Build Back Better’s”/the Inflation Reduction Act’s expansion of the IRS’ budget is justified, or that it will be used effectively to minimize the tax gap. But I do think Yellen’s promise of no audits for filers earning less than $400,000 isn’t to be believed, and perhaps is undesirable: at best it undermines any efforts to truly close the tax gap, maintains inequality, inefficiency, and is truly regressive. Wealthy people pretending to be poor and receiving inequality-mediating benefits are more harmful than high earners marginally underpaying their tax liability, and we need to scrutinize the hell out of them.

The scale of this problem is difficult to assess precisely because of the nature of the tax. This quote from Carl Ichan really exemplifies the muddy waters mindset taken toward one of the nation’s few progressive tax regimes: “There’s a reason it’s called income tax… if you’re a poor person, a rich person, if you are Apple — if you have no income, you don’t pay taxes.” Mechanically, this is true. But when that same system is the primary tool for correcting arguably the worst market failure of modern history, making the rich and poor purely interchangeable is a nightmare. Yet beyond identifying large interest deductions on filings – which may functionally be from personal loans backed by real estate – it’s extremely challenging to anonymously identify how many no or low income filers are actually high wealth and potentially exploiting credits.

Yellen’s promise was also an inappropriate response to criticism of the bill’s allocations for IRS enforcement. On the wilder side, I don’t quite know where Sen. Marjorie Taylor Green got the idea that 70,000 new armed IRS officers were being funded, she never shares a source in her interview and the closes I can get is a document discussing funding for nearly 87,000 full time equivalents/employees by 2031 with no discernment for how many will be armed enforcement agents. But the answer to “why do the tax cops need guns” isn’t “they’re not here for you.” That doesn’t address why more Federal agents need more guns to enforce financial crimes, even if a reasonable excuse exists.

All of this before considering how much of the IRS’ current enforcement is concentrated in low income parts of the country, a much clearer indication of poverty-policing. Even though audits of the rich are really sensitive to changes in IRS funding, it’s notable just how inelastic audits are of low income filers. It means that even as the IRS lost funding they kept the foot down on the filers – particularly those claiming one of the most celebrated bipartisan tax programs in the US’ history – who arguably should benefit from a progressive tax regime.

What’s really necessary is an overhaul of our personal income tax system, one that doesn’t allow filers of wealth to mimic wealth-and-income-poor filers. Personal income taxes shouldn’t only be paid by those too asset poor to afford leverage in perpetuity.

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